The certainty of uncertainty

Nos Experts

25.07.2016

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The current political environment is keeping markets on their toes (Brexit, upcoming US presidential and European elections). While interest rates pull down further into negative territory, the scope of central banks' actions is narrowing down. What does this entail for various asset classes? In this context, where are sound signs to be found? And how do we adjust our asset allocation strategy?

Stanislas de Bailliencourt

In this volatile year, the pro-Brexit vote was a surprise for financial markets. However, once the (over?) reaction - which sent European markets tumbling by over 10% in the two days that followed the result - was over, indices recovered most of their lost ground. While the modus operandi, timing and implementation of the country’s exit from the EU remains unclear, investors are counting on the pragmatism of political leaders and once again, on support from the central banks. The Bank of England has already stated that it was standing ready to ease monetary policy in order to bolster growth (and therefore, implicitly, not to support the pound Sterling through interest rate hikes).

The coming months will continue to be marked by various political events: Italy in the autumn, followed by the US presidential elections in November, and finally Germany and France in 2017.

Facing these uncertainties, investors’ compasses all seem to be pointing in one single direction: central banks. As soon as the referendum results were out, European interest rates plummeted again, breaking all records, pulled down further and further into negative territory by the forces of gravity. Today, all French sovereign bonds with maturities of up to 10 years offer negative yields, with 5-year yields standing at -0.40%. Just think of the real yield this delivers over the period, even with low inflation…

In light of this herd-like and at times, we think, irrational behaviour, we have difficulty believing in the value of these so called “risk-free” bond investments. We are entering uncharted waters as far as these assets are concerned. And it seems rather unlikely that this will all end well.

However this extraordinary environment is also causing the surge of assets prices directly correlated to interest rates, such as commercial real estate or office space. As far as their valuations are concerned, these asset classes draw strength from falling interest rates and are much sought after by institutional investors, desperately seeking yield. The current environment and the regulatory constraints are skewing investors’ capital allocation.

In this context, the equilibrium is sometimes disrupted. The phrase “the Dollar is our currency, but it’s your problem” seems less justified than it once was for the Fed. With the global economy growing at a sluggish pace, the Fed finds itself unable to increase its interest rates to align them with the country’s current growth and inflation levels, as this would cause the Dollar to appreciate sharply… which would weigh on its economy.

Source: Hedgeye

This situation is favourable to emerging countries; they keep on benefiting from the Fed’s particularly accommodative monetary policy and would really not welcome a stronger dollar.

On European markets, jostled by political concerns, tumbling commodity prices or Italian banks, corporate earnings will serve to demonstrate individual companies’ ability to grow in an adverse environment. The frequent volatility spikes observed in recent years, and which will undoubtedly continue to shake the markets in the months to come, will provide us with opportunities to strengthen our core convictions in the portfolios, at attractive prices. Thus, some positions have been strengthened on industry leaders such as Air Liquide or Inditex, cyclical companies with examples like Peugeot as well as stocks that experienced a steep decline, including names like Vivendi.

The frequent volatility spikes observed in recent years, and which will undoubtedly continue to shake the markets in the months to come, will provide us with opportunities to strengthen our core convictions in the portfolios, at attractive prices.

Also worthy of mention is the strong contribution to YTD performance of our bond portfolio, which is up by close to 4% (1) and continues to exhibit attractive yields to maturity.

Within Sycomore Allocation Patrimoine, our asset allocation fund, the option-based hedging strategies helped to contain some of the losses triggered by the Brexit results.

In keeping with its wealth-preservation approach, the fund has returned +0.98% (2) year-to-date, in line with its benchmark, the compounded Eonia +2% (+0.94%) (2) while the Eurostoxx TR is down by -5.84% (3). Over three years, the fund records a robust performance of +23.43% against +6.01% for the compounded Eonia +2%.

(1) Past performance is not a reliable guide to future returns and is not consistent over time.
(2) Performance for the period 31/12/2015 to 21/07/2016.
(3) The performance of the Eurostoxx TR index (dividends included) is provided for information purposes to illustrate the performance of equity markets.
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The opinions and estimates constitute our judgment and are subject to change without notice, as well as assertions about trends in the financial markets, which are based on current conditions in these markets. We believe that the information provided in these pages is reliable, but it should not be considered exhaustive. These data, graphics or extracts were calculated or made on the basis of public information we believe to be reliable but which nevertheless have not been subject to independent verification on our part. Your attention is drawn to the fact that any prediction has its own limitations and that therefore no commitment is made by Sycomore Asset Management as to the achievement of these forecasts. This publication is not intended to be an offer or solicitation for the purchase or sale of any financial instrument whatsoever. References to specific securities and issuers are for the purpose of illustration only and should not be construed as a recommendation to buy or sell these values.